Edgar Filing: SCHWAB CHARLES CORP

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

Commission File Number: 1-9700

THE CHARLES SCHWAB CORPORATION

(Exact name of registrant as specified in its charter)



Delaware (State or other jurisdiction of incorporation or organization)	94-3025021 (I.R.S. Employer Identification No.)

211 Main Street, San Francisco, CA 94105

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (415) 667-7000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer ☒	Accelerated filer ☐
Non-accelerated filer ☐	Smaller reporting company ☐
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the

Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

1,350,452,801 shares of $.01 par value Common Stock Outstanding on October 31, 2018

THE CHARLES SCHWAB CORPORATION

Quarterly Report on Form 10-Q

For the Quarter Ended September 30, 2018

Index



Part I - Financial Information


	Item 1.	Condensed Consolidated Financial Statements (Unaudited):

		Statements of Income	17
		Statements of Comprehensive Income	18
		Balance Sheets	19
		Statements of Stockholders’ Equity	20
		Statements of Cash Flows	21-22
		Notes	23-54

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	1-15

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16

	Item 4.	Controls and Procedures	55

Part II - Other Information

	Item 1.	Legal Proceedings	56

	Item 1A.	Risk Factors	56

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56

	Item 3.	Defaults Upon Senior Securities	56

	Item 4.	Mine Safety Disclosures	56

	Item 5.	Other Information	56

	Item 6.	Exhibits	57

Signature			58

Part I – FINANCIAL INFORMATION

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

The Charles Schwab Corporation (CSC) is a savings and loan holding company engaged, through its subsidiaries, in wealth management, securities brokerage, banking, asset management, custody, and financial advisory services.

Significant business subsidiaries of CSC include the following:


•	Charles Schwab & Co., Inc. (CS&Co), a securities broker-dealer;


•	Charles Schwab Bank (CSB), a federal savings bank; and


•	Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary mutual funds (Schwab Funds^®) and Schwab’s exchange-traded funds (Schwab ETFs™).

Unless otherwise indicated, the terms “Schwab,” “the Company,” “we,” “us,” or “our” mean CSC together with its consolidated subsidiaries.

Schwab provides financial services to individuals and institutional clients through two segments – Investor Services and Advisor Services. The Investor Services segment provides retail brokerage and banking services to individual investors, and retirement plan services, as well as other corporate brokerage services, to businesses and their employees. The Advisor Services segment provides custodial, trading, banking, and support services, as well as retirement business services, to independent registered investment advisors (RIAs), independent retirement advisors, and recordkeepers.

Schwab was founded on the belief that all Americans deserve access to a better investing experience. Although much has changed in the intervening years, our purpose remains clear – to champion every client’s goals with passion and integrity. Guided by this purpose and the aspiration of creating the most trusted leader in investment services, management has adopted a strategy described as “Through Clients’ Eyes.”

This strategy emphasizes placing clients’ perspectives, needs, and desires at the forefront. Because investing plays a fundamental role in building financial security, we strive to deliver a better investing experience for our clients – individual investors and the people and institutions who serve them – by disrupting longstanding industry practices on their behalf and providing superior service. We also aim to offer a broad range of products and solutions to meet client needs with a focus on transparency, value, and trust. In addition, management works to couple Schwab’s scale and resources with ongoing expense discipline to keep costs low and ensure that products and solutions are affordable as well as responsive to client needs. In combination, these are the key elements of our “no trade-offs” approach to serving investors. We believe that following this strategy is the best way to maximize our market valuation and stockholder returns over time.

Management estimates that investable wealth in the United States (consisting of assets in defined contribution, retail wealth management and brokerage, and registered investment advisor channels, along with bank deposits) currently exceeds $45 trillion, which means the Company’s $3.56 trillion in client assets leaves substantial opportunity for growth. Our strategy is based on the principle that developing trusted relationships will translate into more assets from both new and existing clients, ultimately driving more revenue, and along with expense discipline, will generate earnings growth and build long-term stockholder value.

This Management’s Discussion and Analysis should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (2017 Form 10-K).

On our website, www.aboutschwab.com, we post the following filings after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC): annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The SEC maintains a website at www.sec.gov that contains reports, proxy, and other information that we file electronically with the SEC.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate,” “appear,” “could,” “would,” and other similar expressions. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances are forward-looking statements.

These forward-looking statements, which reflect management’s beliefs, objectives, and expectations as of the date hereof, are estimates based on the best judgment of Schwab’s senior management. These statements relate to, among other things:


•	Maximizing our market valuation and stockholder returns over time; our belief that developing trusted relationships will translate into more client assets which drives revenue and, along with expense discipline, generates earnings growth and builds stockholder value (see Introduction in Part I, Item 2);


•	Ongoing investments to drive growth and efficiency (see Overview);


•	Capital expenditures in 2018 (see Results of Operations);


•	Consolidated balance sheet assets remaining above $250 billion (see Risk Management and Capital Management);


•	The expected impact of new accounting standards not yet adopted (see New Accounting Standards in Part I, Item 1, Financial Information – Notes to Condensed Consolidated Financial Statements (Item 1) – Note 2);


•	The likelihood of indemnification and guarantee payment obligations (see Commitments and Contingencies in Item 1 – Note 9); and


•	The impact of legal proceedings and regulatory matters (see Commitments and Contingencies in Item 1 – Note 9 and Legal Proceedings in Part II, Item 1).

Achievement of the expressed beliefs, objectives, and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives, and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q or, in the case of documents incorporated by reference, as of the date of those documents.

Important factors that may cause actual results to differ include, but are not limited to:


•	General market conditions, including the level of interest rates, equity valuations, and trading activity;


•	Our ability to attract and retain clients, develop trusted relationships, and grow client assets;


•	Client use of our advice solutions and other products and services;


•	The level of client assets, including cash balances;


•	Competitive pressure on pricing, including deposit rates;


•	Client sensitivity to interest rates;


•	Regulatory guidance;


•	Timing and amount of transfers of certain balances from sweep money market funds into bank sweep deposits;


•	Capital and liquidity needs and management;


•	Our ability to manage expenses;


•	Our ability to develop and launch new products, services, and capabilities, as well as implement infrastructure, in a timely and successful manner;


•	The effect of adverse developments in litigation or regulatory matters and the extent of any related charges; and


•	Potential breaches of contractual terms for which we have indemnification and guarantee obligations.

Certain of these factors, as well as general risk factors affecting the Company, are discussed in greater detail in Part I – Item 1A – Risk Factors in the 2017 Form 10-K.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

OVERVIEW

Management focuses on several client activity and financial metrics in evaluating Schwab’s financial position and operating performance. Results for the third quarters and first nine months of 2018 and 2017 are:



	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2018			2017			Percent Change		2018			2017			Percent Change
Client Metrics
Net new client assets (in billions) ⁽¹⁾	$	53.5		$	51.6		4	%	$	78.6		$	155.0		(49	)%
Core net new client assets (in billions)	$	53.5		$	51.6		4	%	$	172.5		$	136.7		26	%
Client assets (in billions, at quarter end)	$	3,563.7		$	3,181.2		12	%
Average client assets (in billions)	$	3,508.1		$	3,107.8		13	%	$	3,420.2		$	2,986.3		15	%
New brokerage accounts (in thousands)	369			336			10	%	1,196			1,055			13	%
Active brokerage accounts (in thousands, at quarter end)	11,423			10,565			8	%
Assets receiving ongoing advisory services (in billions, at quarter end)	$	1,851.9		$	1,613.6		15	%
Client cash as a percentage of client assets (at quarter end)	10.3		%	11.1		%
Company Financial Metrics
Total net revenues	$	2,579		$	2,165		19	%	$	7,463		$	6,376		17	%
Total expenses excluding interest	1,360			1,220			11	%	4,111			3,679			12	%
Income before taxes on income	1,219			945			29	%	3,352			2,697			24	%
Taxes on income	296			327			(9	)%	780			940			(17	)%
Net income	923			618			49	%	2,572			1,757			46	%
Preferred stock dividends and other	38			43			(12	)%	128			127			1	%
Net income available to common stockholders	$	885		$	575		54	%	$	2,444		$	1,630		50	%
Earnings per common share — diluted	$	.65		$	.42		55	%	$	1.79		$	1.21		48	%
Net revenue growth from prior year	19		%	13		%			17		%	16		%
Pre-tax profit margin	47.3		%	43.6		%			44.9		%	42.3		%
Return on average common stockholders’ equity	20		%	15		%			19		%	15		%
Expenses excluding interest as a percentage of average client assets (annualized)	0.15		%	0.16		%			0.16		%	0.16		%
Consolidated Tier 1 Leverage Ratio (at quarter end)	7.5		%	7.7		%

⁽¹⁾The first nine months of 2018 includes outflows of $93.9 billion from certain mutual fund clearing services clients. The first nine months of 2017 includes inflows of $18.3 billion from certain mutual fund clearing services clients.

Net income grew 49% and 46% for the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, driven primarily by business momentum, a generally favorable economic environment, and lower corporate income taxes. Total net revenues rose 19% and 17% in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, primarily due to higher net interest revenue as a result of higher interest rates and larger client cash sweep balances. Total expenses excluding interest grew 11% and 12% during the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, reflecting hiring to support the Company’s expanding client base and ongoing investments for driving growth and efficiency. Pre-tax income increased 29% and 24% in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, delivering a 44.9% pre-tax profit margin for the first nine months of 2018.

Taxes on income decreased 9% and 17% for the third quarter and first nine months of 2018, compared to the same periods in 2017, resulting in effective tax rates of 24.3% and 23.3% for the third quarter and first nine months of 2018, respectively. The reduction in taxes on income was due to the Tax Act of 2017, which lowered the federal corporate income tax rate from 35% to 21% effective January 1, 2018.

During the third quarter of 2018, clients opened 369,000 new brokerage accounts, helping to bring active brokerage accounts to 11.4 million at September 30, 2018. Core net new assets gathered during the third quarter of 2018 were $53.5 billion, compared to $51.6 billion for the same period a year ago. Client engagement remained strong during the third quarter of 2018, with daily average revenue trades rising 22% from the same period in 2017.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

During the third quarter of 2018, we effectively managed our balance sheet to support both growth and solid financial performance. The consolidated balance sheet reached $272 billion of assets at September 30, 2018, a $10 billion quarterly increase, largely driven by bank sweep transfers and client activity. We transferred balances totaling $23 billion from sweep money market funds to bank sweep in the quarter, bringing our 2018 transfers to $68 billion and leaving $33 billion remaining in sweep money market funds at September 30, 2018. In July 2018, the Board of Directors declared a 30% increase in the quarterly cash dividend to $.13 per common share. We finished the quarter with a Tier 1 Leverage Ratio of 7.5%, and we lifted our return on equity to 20% and 19% for the third quarter and first nine months of 2018, respectively, compared to 15% for the same periods in 2017.

Subsequent Events

On October 25, 2018, CSC’s Board of Directors terminated the existing two share repurchase authorizations and replaced them with a new authorization to repurchase up to a total of $1.0 billion of common stock.

On October 31, 2018, CSC issued $500 million aggregate principal amount of Senior Notes that mature in 2024 and $600 million aggregate principal amount of Senior Notes that mature in 2029 under its universal shelf registration statement on file with the SEC. The Senior Notes due 2024 have a fixed interest rate of 3.550% with interest payable semi-annually. The Senior Notes due 2029 have a fixed interest rate of 4.000% with interest payable semi-annually.

Current Regulatory Environment and Other Developments

On October 31, 2018, the Board of Governors of the Federal Reserve System (Federal Reserve) issued a notice of proposed rulemaking and the Federal Reserve, the Office of the Comptroller of Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) jointly issued another notice of proposed rulemaking. The two proposals would establish a revised framework for applying enhanced prudential standards to large U.S. banking organizations, including savings and loan holding companies such as CSC, with four categories of standards that reflect the risks of banking organizations in each group. CSC would be in Category III based on having $250 billion – $700 billion in total assets. The comment period for both proposed rules ends on January 22, 2019 and we are currently evaluating the impact of the proposed rules.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

RESULTS OF OPERATIONS

Total Net Revenues

The following tables present a comparison of revenue by category:



			2018					2017
Three Months Ended September 30,	Percent Change		Amount			% of Total Net Revenues		Amount			% of Total Net Revenues
Net interest revenue
Interest revenue	49	%	$	1,755		68	%	$	1,176		54	%
Interest expense	143	%	(228		)	(9	)%	(94		)	(4	)%
Net interest revenue	41	%	1,527			59	%	1,082			50	%
Asset management and administration fees
Mutual funds and ETF service fees	(16	)%	435			17	%	519			24	%
Advice solutions	11	%	294			11	%	265			12	%
Other	4	%	80			3	%	77			4	%
Asset management and administration fees	(6	)%	809			31	%	861			40	%
Trading revenue
Commissions	14	%	155			6	%	136			6	%
Principal transactions	40	%	21			1	%	15			1	%
Trading revenue	17	%	176			7	%	151			7	%
Other	(6	)%	67			3	%	71			3	%
Total net revenues	19	%	$	2,579		100	%	$	2,165		100	%



			2018					2017
Nine Months Ended September 30,	Percent Change		Amount			% of Total Net Revenues		Amount			% of Total Net Revenues
Net interest revenue
Interest revenue	42	%	$	4,766		64	%	$	3,358		52	%
Interest expense	155	%	(569		)	(8	)%	(223		)	(3	)%
Net interest revenue	34	%	4,197			56	%	3,135			49	%
Asset management and administration fees
Mutual funds and ETF service fees	(10	)%	1,386			19	%	1,538			24	%
Advice solutions	12	%	859			11	%	765			12	%
Other	1	%	229			3	%	226			4	%
Asset management and administration fees	(2	)%	2,474			33	%	2,529			40	%
Trading revenue
Commissions	10	%	501			7	%	456			7	%
Principal transactions	27	%	56			1	%	44			1	%
Trading revenue	11	%	557			8	%	500			8	%
Other	11	%	235			3	%	212			3	%
Total net revenues	17	%	$	7,463		100	%	$	6,376		100	%

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Net Interest Revenue

The following tables present net interest revenue information corresponding to interest-earning assets and funding sources on the condensed consolidated balance sheets:



	2018						2017
Three Months Ended September 30,	Average Balance		Interest Revenue/ Expense		Average Yield/ Rate		Average Balance		Interest Revenue/ Expense		Average Yield/ Rate
Interest-earning assets
Cash and cash equivalents	$	18,623	$	94	1.98	%	$	10,498	$	33	1.25	%
Cash and investments segregated	10,253		51		1.94	%	17,355		44		1.01	%
Broker-related receivables	307		1		1.94	%	459		1		0.96	%
Receivables from brokerage clients	20,224		217		4.19	%	16,498		151		3.63	%
Available for sale securities⁽¹⁾	55,283		328		2.34	%	45,906		187		1.62	%
Held to maturity securities	137,065		887		2.57	%	107,557		606		2.24	%
Bank loans	16,579		142		3.43	%	16,058		122		3.01	%
Total interest-earning assets	258,334		1,720		2.63	%	214,331		1,144		2.12	%
Other interest revenue			35						32
Total interest-earning assets	$	258,334	$	1,755	2.69	%	$	214,331	$	1,176	2.18	%
Funding sources
Bank deposits	$	208,666	$	158	0.30	%	$	163,039	$	49	0.12	%
Payables to brokerage clients	20,595		16		0.31	%	24,833		6		0.10	%
Short-term borrowings	—		—		—		1,695		6		1.40	%
Long-term debt	5,790		51		3.52	%	3,436		30		3.46	%
Total interest-bearing liabilities	235,051		225		0.38	%	193,003		91		0.19	%
Non-interest-bearing funding sources	23,283						21,328
Other interest expense			3						3
Total funding sources	$	258,334	$	228	0.36	%	$	214,331	$	94	0.18	%
Net interest revenue			$	1,527	2.33	%			$	1,082	2.00	%



	2018						2017
Nine Months Ended September 30,	Average Balance		Interest Revenue/ Expense		Average Yield/ Rate		Average Balance		Interest Revenue/ Expense		Average Yield/ Rate
Interest-earning assets
Cash and cash equivalents	$	16,164	$	217	1.78	%	$	9,375	$	72	1.03	%
Cash and investments segregated	12,002		149		1.64	%	19,609		120		0.82	%
Broker-related receivables	324		4		1.62	%	428		2		0.74	%
Receivables from brokerage clients	19,629		600		4.03	%	15,861		415		3.50	%
Available for sale securities⁽¹⁾	52,797		859		2.16	%	55,070		615		1.49	%
Held to maturity securities	129,490		2,420		2.48	%	99,523		1,691		2.27	%
Bank loans	16,522		410		3.31	%	15,764		347		2.94	%
Total interest-earning assets	246,928		4,659		2.50	%	215,630		3,262		2.02	%
Other interest revenue			107						96
Total interest-earning assets	$	246,928	$	4,766	2.56	%	$	215,630	$	3,358	2.08	%
Funding sources
Bank deposits	$	193,010	$	339	0.23	%	$	163,475	$	98	0.08	%
Payables to brokerage clients	21,591		37		0.23	%	26,198		11		0.06	%
Short-term borrowings	4,488		54		1.59	%	1,475		11		1.00	%
Long-term debt	5,053		131		3.46	%	3,349		89		3.55	%
Total interest-bearing liabilities	224,142		561		0.33	%	194,497		209		0.14	%
Non-interest-bearing funding sources	22,786						21,133
Other interest expense			8						14
Total funding sources	$	246,928	$	569	0.31	%	$	215,630	$	223	0.14	%
Net interest revenue			$	4,197	2.25	%			$	3,135	1.94	%

⁽¹⁾Amounts have been calculated based on amortized cost.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Net interest revenue increased $445 million, or 41%, and $1.1 billion, or 34%, in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, primarily due to higher interest rates and growth in interest-earning assets.

Our net interest margin improved to 2.33% and 2.25% during the third quarter and first nine months of 2018, respectively, up from 2.00% and 1.94% during the same periods in 2017, primarily as a result of the Federal Reserve’s 2017 and March, June, and September 2018 interest rate increases, partially offset by higher interest rates paid on bank deposits and other interest-bearing liabilities.

During the third quarter and the first nine months of 2018, average interest earning assets grew 21% and 15%, respectively, compared to the same periods in 2017. These increases reflect higher bank deposits due to transfers from sweep money market funds to bank sweep balances, as well as other client-related deposit inflows and higher borrowings, partially offset by client purchases of other assets. During the first six months of 2018, Schwab issued senior notes and utilized Federal Home Loan Bank (FHLB) advances to provide temporary funding for additional investments ahead of deposit growth. There were no FHLB borrowings in the third quarter of 2018.

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THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Asset Management and Administration Fees

The following tables present asset management and administration fees, average client assets, and average fee yields:



Three Months Ended September 30,	2018						2017
Three Months Ended September 30,	Average Client Assets		Revenue		Average Fee		Average Client Assets		Revenue			Average Fee
Schwab money market funds before fee waivers	$	130,202	$	122	0.37	%	$	158,927	$	220		0.55	%
Fee waivers			—						(1		)
Schwab money market funds	130,202		122		0.37	%	158,927		219			0.55	%
Schwab equity and bond funds and ETFs	219,137		67		0.12	%	164,011		56			0.14	%
Mutual Fund OneSource^® and other non-transaction fee funds	209,560		171		0.32	%	219,076		179			0.32	%
Other third-party mutual funds and ETFs ⁽¹⁾	342,316		75		0.09	%	291,307		65			0.09	%
Total mutual funds and ETFs ⁽²⁾	$	901,215	435		0.19	%	$	833,321	519			0.25	%
Advice solutions ⁽²⁾
Fee-based	$	234,338	294		0.50	%	$	206,854	265			0.51	%
Non-fee-based	65,146		—		—		50,758		—			—
Total advice solutions	$	299,484	294		0.39	%	$	257,612	265			0.41	%
Other balance-based fees⁽³⁾	400,048		63		0.06	%	424,280		67			0.06	%
Other ⁽⁴⁾			17						10
Total asset management and administration fees			$	809					$	861



Nine Months Ended September 30,	2018						2017
Nine Months Ended September 30,	Average Client Assets		Revenue		Average Fee		Average Client Assets		Revenue			Average Fee
Schwab money market funds before fee waivers	$	142,177	$	451	0.42	%	$	160,230	$	675		0.56	%
Fee waivers			—						(10		)
Schwab money market funds	142,177		451		0.42	%	160,230		665			0.55	%
Schwab equity and bond funds and ETFs	206,058		195		0.13	%	151,579		163			0.14	%
Mutual Fund OneSource^® and other non-transaction fee funds	216,699		524		0.32	%	214,058		528			0.33	%
Other third-party mutual funds and ETFs ⁽¹⁾	329,033		216		0.09	%	278,479		182			0.09	%
Total mutual funds and ETFs ⁽²⁾	$	893,967	1,386		0.21	%	$	804,346	1,538			0.26	%
Advice solutions ⁽²⁾
Fee-based	$	228,326	859		0.50	%	$	199,500	765			0.51	%
Non-fee-based	62,377		—		—		46,785		—			—
Total advice solutions	$	290,703	859		0.40	%	$	246,285	765			0.42	%
Other balance-based fees ⁽³⁾	404,596		191		0.06	%	406,442		192			0.06	%
Other ⁽⁴⁾			38						34
Total asset management and administration fees			$	2,474					$	2,529

⁽¹⁾ Includes Schwab ETF OneSource™.

⁽²⁾ Beginning in the fourth quarter of 2017, a change was made to add non-fee-based average assets from managed portfolios. Average client assets for advice solutions may also include the asset balances contained in the mutual fund and/or ETF categories listed above. Prior periods have been adjusted to accommodate this change.

⁽³⁾ Includes various asset-related fees, such as trust fees, 401(k) recordkeeping fees, and mutual fund clearing fees and other service fees.

⁽⁴⁾ Includes miscellaneous service and transaction fees relating to mutual funds and ETFs that are not balance-based.

Asset management and administration fees decreased by $52 million, or 6%, and $55 million, or 2%, in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017. The decreases were due to lower money market

- 8 -

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions. Part of the declines were offset by revenue from growing asset balances in advice solutions, equity and bond funds, and ETFs.

The following tables present a roll forward of client assets for the Schwab money market funds, Schwab equity and bond funds and exchange-traded funds (ETFs), and Mutual Fund OneSource^®and other non-transaction fee (NTF) funds. These funds generated 44% and 47% of the asset management and administration fees earned during the third quarter and first nine months of 2018, respectively, compared to 53% and 54% for the same periods in 2017:



	Schwab Money Market Funds					Schwab Equity and Bond Funds and ETFs				Mutual Fund OneSource^® and Other NTF funds
Three Months Ended September 30,	2018			2017		2018		2017		2018			2017
Balance at beginning of period	$	134,166		$	156,186	$	201,361	$	151,336	$	212,513		$	224,749
Net inflows (outflows)	(6,204		)	2,753		6,596		7,086		(7,126		)	(13,255		)
Net market gains (losses) and other	522			235		8,899		6,676		7,228			9,684
Balance at end of period	$	128,484		$	159,174	$	216,856	$	165,098	$	212,615		$	221,178



	Schwab Money Market Funds						Schwab Equity and Bond Funds and ETFs				Mutual Fund OneSource^® and Other NTF funds
Nine Months Ended September 30,	2018			2017			2018		2017		2018			2017
Balance at beginning of period	$	163,650		$	163,495		$	181,608	$	125,813	$	225,202		$	198,924
Net inflows (outflows)	(36,645		)	(4,832		)	24,867		22,347		(25,403		)	(23,494		)
Net market gains (losses) and other ⁽¹⁾	1,479			511			10,381		16,938		12,816			45,748
Balance at end of period	$	128,484		$	159,174		$	216,856	$	165,098	$	212,615		$	221,178

⁽¹⁾ Includes net inflows from other third-party mutual funds to Mutual Fund OneSource^®in the second quarter of 2017.

Trading Revenue

The following table presents trading revenue and the related drivers:



	Three Months Ended September 30,				Percent Change		Nine Months Ended September 30,				Percent Change
	2018		2017		Percent Change		2018		2017		Percent Change
Daily average revenue trades (DARTs) (in thousands)	382		312		22	%	406		313		30	%
Clients’ daily average trades (in thousands)	683		633		8	%	732		602		22	%
Number of trading days	62.5		62.5		—		187.5		187.5		—
Daily average revenue per revenue trade	$	7.27	$	7.74	(6	)%	$	7.27	$	8.52	(15	)%
Trading revenue	$	176	$	151	17	%	$	557	$	500	11	%

DART volumes increased 22% and 30% in the third quarter and first nine months of 2018, respectively, compared to the prior year. This led to an increase in trading revenue of $25 million, or 17%, and $57 million, or 11%, in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, as the volume growth more than offset Schwab’s commission pricing reductions implemented in the first quarter of 2017. During that time, we announced two trading price reductions which lowered standard equity, ETF, and option trade commissions from $8.95 to $4.95 and lowered the per contract option fee from $.75 to $.65.

Other Revenue

Other revenue includes order flow revenue, other service fees, software fees from our portfolio management solutions, exchange processing fees, and non-recurring gains. Order flow revenue was $33 million and $29 million during the third quarters of 2018 and 2017, respectively, and $104 million and $82 million during the first nine months of 2018 and 2017, respectively. These increases were primarily due to higher rates on certain types of orders and higher volume of trades.

- 9 -

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Total Expenses Excluding Interest

The following table shows a comparison of expenses excluding interest:



	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2018			2017			Percent Change		2018			2017			Percent Change
Compensation and benefits
Salaries and wages	$	423		$	372		14	%	$	1,253		$	1,110		13	%
Incentive compensation	193			187			3	%	615			580			6	%
Employee benefits and other	121			103			17	%	384			336			14	%
Total compensation and benefits	$	737		$	662		11	%	$	2,252		$	2,026		11	%
Professional services	164			152			8	%	476			429			11	%
Occupancy and equipment	124			111			12	%	368			323			14	%
Advertising and market development	70			63			11	%	220			205			7	%
Communications	59			56			5	%	179			171			5	%
Depreciation and amortization	78			69			13	%	226			200			13	%
Regulatory fees and assessments	57			43			33	%	158			133			19	%
Other	71			64			11	%	232			192			21	%
Total expenses excluding interest	$	1,360		$	1,220		11	%	$	4,111		$	3,679		12	%
Expenses as a percentage of total net revenues
Compensation and benefits	29		%	31		%			30		%	32		%
Advertising and market development	3		%	3		%			3		%	3		%
Full-time equivalent employees (in thousands)
At quarter end	19.1			17.3			10	%
Average	19.0			17.1			11	%	18.4			16.7			10	%

Total compensation and benefits increased in the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to an increase in employee headcount to support our expanding client base.

Professional services expense increased in the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to higher spending on technology projects, as well as an increase in asset management and administration-related expenses resulting from growth in the Schwab Funds^® and Schwab ETFs™.

Occupancy and equipment expense increased in the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to an increase in software maintenance expenses and additional licenses to support growth in the business.

Depreciation and amortization expenses grew in the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to higher amortization of internally developed software associated with continued investments in software and technology enhancements.

Regulatory fees and assessments increased in the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to an increase in FDIC insurance assessments, which rose as a result of higher average assets.

Other expenses increased in the first nine months of 2018 compared to the same period in 2017, primarily due to a $15 million charge in the first quarter of 2018 associated with unsecured client margin losses in volatility-related products and other miscellaneous expense growth related to the expanding client base.

Capital expenditures were $156 million and $417 million in the third quarter and first nine months of 2018, respectively, compared with $118 million and $271 million in the third quarter and first nine months of 2017, respectively. The increases in the third quarter and year-to-date capital expenditures from the same periods in 2017 were due primarily to our office campus expansion in the U.S. and investments in technology projects. We anticipate capital expenditures for full-year 2018 will reach approximately 6-7% of total net revenues.

- 10 -

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Taxes on Income

Taxes on income were $296 million and $327 million for the third quarters of 2018 and 2017, respectively, resulting in effective income tax rates on income before taxes of 24.3% and 34.6%, respectively. Taxes on income were $780 million and $940 million for the first nine months of 2018 and 2017, respectively, resulting in effective income tax rates on income before taxes of 23.3% and 34.9%, respectively. The decrease in the effective tax rate was primarily due to the Tax Act which was signed into law on December 22, 2017. Among other things, the Tax Act lowered the federal corporate income tax rate from 35% to 21%, effective for tax years including or commencing January 1, 2018.

Segment Information

Financial information for our segments is presented in the following tables:



	Investor Services						Advisor Services						Total
Three Months Ended September 30,	Percent Change		2018		2017		Percent Change		2018		2017		Percent Change		2018		2017
Net Revenues
Net interest revenue	39	%	$	1,138	$	818	47	%	$	389	$	264	41	%	$	1,527	$	1,082
Asset management and administration fees	(5	)%	565		595		(8	)%	244		266		(6	)%	809		861
Trading revenue	19	%	112		94		12	%	64		57		17	%	176		151
Other	(2	)%	53		54		(18	)%	14		17		(6	)%	67		71
Total net revenues	20	%	1,868		1,561		18	%	711		604		19	%	2,579		2,165
Expenses Excluding Interest	11	%	1,015		918		14	%	345		302		11	%	1,360		1,220
Income before taxes on income	33	%	$	853	$	643	21	%	$	366	$	302	29	%	$	1,219	$	945



	Investor Services						Advisor Services						Total
Nine Months Ended September 30,	Percent Change		2018		2017		Percent Change		2018		2017		Percent Change		2018		2017
Net Revenues
Net interest revenue	33	%	$	3,158	$	2,366	35	%	$	1,039	$	769	34	%	$	4,197	$	3,135
Asset management and administration fees	(1	)%	1,727		1,743		(5	)%	747		786		(2	)%	2,474		2,529
Trading revenue	14	%	354		311		7	%	203		189		11	%	557		500
Other	14	%	182		159		—		53		53		11	%	235		212
Total net revenues	18	%	5,421		4,579		14	%	2,042		1,797		17	%	7,463		6,376
Expenses Excluding Interest	11	%	3,069		2,762		14	%	1,042		917		12	%	4,111		3,679
Income before taxes on income	29	%	$	2,352	$	1,817	14	%	$	1,000	$	880	24	%	$	3,352	$	2,697

Investor Services

Total net revenues rose by 20% and 18% in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, primarily due to an increase in net interest revenue, partially offset by lower asset management and administration fees. Net interest revenue increased due to higher net interest margins and higher interest-earning assets. Asset management and administration fees decreased primarily due to lower money market fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions.

Expenses excluding interest increased by 11% in both the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to higher compensation and benefits, technology project spend, and asset management and administration-related expenses to support our expanding client base.

- 11 -

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Advisor Services

Total net revenues rose by 18% and 14% in the third quarter and first nine months of 2018, respectively, compared to the same periods in 2017, primarily due to an increase in net interest revenue, partially offset by lower asset management and administration fees. Net interest revenue increased due to higher net interest margins and higher interest-earning assets. Asset management and administration fees decreased primarily due to lower money market fund revenue as a result of transfers to bank sweep, client asset allocation choices, and our 2017 fee reductions.

Expenses excluding interest increased by 14% in both the third quarter and first nine months of 2018 compared to the same periods in 2017, primarily due to higher compensation and benefits, technology project spend, and asset management and administration-related expenses to support our expanding client base.

RISK MANAGEMENT

Schwab’s business activities expose us to a variety of risks, including operational, credit, market, liquidity, and compliance risk. The Company has a comprehensive risk management program to identify and manage these risks and their associated potential for financial and reputational impact. For a discussion of our risk management programs, see Item 7 – Risk Management in the 2017 Form 10-K.

Net Interest Revenue Simulation

For Schwab’s net interest revenue sensitivity analysis, we use net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation includes all interest-sensitive assets and liabilities. Key variables in the simulation include the repricing of financial instruments, prepayment, reinvestment, and product pricing assumptions. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate the impact of changes in interest rates on net interest revenue. Actual results may differ from simulated results due to balance growth or decline and the timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, including changes in asset and liability mix.

If our guidelines for net interest revenue sensitivity are breached, management must report the breach to the Financial Risk Oversight Committee and establish a plan to address the interest rate risk. There were no breaches of Schwab’s net interest revenue sensitivity risk limits during the nine months ended September 30, 2018, or year ended December 31, 2017.

As represented by the simulations presented below, our investment strategy is structured to produce an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when interest rates fall.

The simulations in the following table assume that the asset and liability structure of the consolidated balance sheets would not be changed as a result of the simulated changes in interest rates. As we actively manage the consolidated balance sheets and interest rate exposure, in all likelihood we would take steps to manage additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the simulated net interest revenue change over the next 12 months beginning September 30, 2018 and December 31, 2017 of a gradual 100 basis point increase or decrease in market interest rates relative to prevailing market rates at the end of each reporting period:



	September 30, 2018		December 31, 2017
Increase of 100 basis points	4.1	%	3.3	%
Decrease of 100 basis points	(4.7	)%	(6.2	)%

The change in net interest revenue sensitivities as of September 30, 2018 reflects the increase in interest rates across all maturities.

- 12 -

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

Liquidity Risk

Schwab’s primary source of funds is cash generated by client activity: bank deposits and cash balances in client brokerage accounts. These funds are used to purchase investment securities and extend loans to clients.

Other sources of funds may include cash flows from operations, maturities and sales of investment securities, repayments on loans, securities lending of assets held in client brokerage accounts, and cash provided by external debt or equity financing.

To meet daily funding needs, we maintain liquidity in the form of overnight cash deposits and short-term investments. For unanticipated liquidity needs, a buffer of highly liquid investments, currently comprised of U.S. Treasury notes, is also maintained.

In addition to internal sources of liquidity, Schwab has access to external funding. The following table describes external debt facilities available at September 30, 2018:



Description	Borrower	Outstanding		Available
Committed, unsecured credit facility with various external banks	CSC	$	—	$	750
Uncommitted, unsecured lines of credit with various external banks	CSC, CS&Co	—		1,432
Federal Reserve Bank discount window ⁽¹⁾	CSB	—		2,422
Federal Home Loan Bank secured credit facility ⁽²⁾	Banking subsidiaries	—		30,002
Unsecured commercial paper ⁽³⁾	CSC	—		750

⁽¹⁾Amounts available are dependent on the fair value of certain investment securities that are pledged as collateral.

⁽²⁾ Amounts available are dependent on the amount of first lien residential real estate mortgage loans (First Mortgages), home equity lines of credit (HELOCs), and the fair value of certain investment securities that are pledged as collateral.

⁽³⁾CSC has authorization from its Board of Directors to issue Commercial Paper Notes to not exceed $1.5 billion. Management has set a current limit not to exceed the amount of the committed, unsecured credit facility.

CSC’s ratings for Commercial Paper Notes are P1 by Moody’s Investor Service (Moody’s), A1 by Standard & Poor’s Rating Group (Standard & Poor’s), and F1 by Fitch Ratings, Ltd (Fitch).

Borrowings

The following are details of the Senior Notes and short-term borrowings:



September 30, 2018	Par Outstanding		Maturity	Weighted Average Interest Rate	Moody’s	Standard & Poor’s	Fitch
Senior Notes	$	5,781	2020 - 2028	3.31%	A2	A	A
Short-term borrowings	$	—	N/A	N/A	N/A	N/A	N/A

N/A Not applicable.

New Debt Issuances

All debt issuances in 2018 were senior unsecured obligations with interest payable quarterly or semi-annually. Additional details are as follows:



Issuance Date	Issuance Amount		Maturity Date	Interest Rate	Interest Payable
May 22, 2018	$	600	5/21/2021	Three-month LIBOR + 0.32%	Quarterly
May 22, 2018	$	600	5/21/2021	3.25%	Semi-annually
May 22, 2018	$	750	5/21/2025	3.85%	Semi-annually

Schwab is subject to, and was in compliance with, the modified liquidity coverage ratio (LCR) rule at September 30, 2018. Schwab expects consolidated balance sheet assets to remain above $250 billion in 2018, and as a result, would become subject to the full LCR rule in 2019.

- 13 -

THE CHARLES SCHWAB CORPORATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Millions, Except Ratios, or as Noted)

CAPITAL MANAGEMENT

Schwab seeks to manage capital to a level and composition sufficient to support execution of our business strategy, including anticipated balance sheet growth, providing financial support to our subsidiaries, and sustained access to the capital markets, while at the same time meeting our regulatory capital requirements, and serving as a source of financial strength to our banking subsidiaries. Schwab’s primary sources of capital are funds generated by the operations of subsidiaries and securities issuances by CSC in the capital markets. To ensure that Schwab has sufficient capital to absorb unanticipated losses or declines in asset values, we have adopted a policy to remain well capitalized even in stressed scenarios.

Regulatory Capital Requirements

CSC and CSB are subject to various capital requirements set by regulatory agencies as discussed in further detail in the 2017 Form 10-K and in Item 1 – Note 16. As of September 30, 2018, CSC and CSB are considered well capitalized.

The following table details CSC’s consolidated and CSB’s capital ratios as of September 30, 2018 and December 31, 2017:



	September 30, 2018				December 31, 2017
	CSC		CSB		CSC		CSB
Total stockholders’ equity	$	20,834	$	14,899	$	18,525	$	13,224
Less:
Preferred stock	2,793		—		2,793		—
Common Equity Tier 1 Capital before regulatory adjustments	$	18,041	$